Saturday, July 27, 2013

President Obama's Big, Frothy Hint

President Obama, in an interview with the New York Times, said a few sentences about what he's looking for in the next Fed chair. A few newspapers, including the Washington Post, have already exclaimed that "President Barack Obama says his next Fed chairman should take ordinary people into account when setting monetary policy."

President Obama indeed mentions "the lives of ordinary Americans getting better." But taken in context, his remarks are surprisingly inflation-hawkish and relatively unconcerned with unemployment. He says:
And what I’m looking for is somebody who understands the Fed has a dual mandate, that that’s not just lip service; that it is very important to keep inflation in check, to keep our dollar sound, and to ensure stability in the markets. But the idea is not just to promote those things in the abstract. The idea is to promote those things in service of the lives of ordinary Americans getting better. And when unemployment is still too high, and long-term unemployment is still too high, and there’s still weak demand in a lot of industries, I want a Fed chairman that can step back and look at that objectively and say, let’s make sure that we’re growing the economy, but let’s also keep an eye on inflation, and if it starts eating up, if the markets start frothing up, let’s make sure that we’re not creating new bubbles.
When he says "The idea is to promote those things in service of the lives of ordinary Americans getting better," those things refers to keeping inflation in check, keeping the dollar sound, and ensuring stability in the markets. He's emphasizing the price stability part of the dual mandate much more than the maximum employment part. When he then goes on to mention high unemployment (a much bigger impediment to the lives of ordinary Americans getting better, in my opinion), he is remarkably quick to mention keeping an eye on inflation in the very same sentence.

The President says he wants "somebody who understands the Fed has a dual mandate," but somebody who truly understood this would recognize that the Fed's efforts in this economic environment should be focused on restoring full employment.

And then there are the remarks about frothing markets and bubbles. Now, President Obama refused to answer the NYT reporter's question about who he was considering for chairman--in particular, he refused to say whether he was planning to appoint Larry Summers--but this is a pretty big hint. Fed officials are split over the appropriate role of the Fed in trying to identify and constrain asset bubbles. The so-called "Bernanke doctrine" holds that monetary policy should be used to deal with normal macroeconomic concerns, while regulatory policies should be used to try to alleviate financial imbalances. Ben Bernanke, of course, is a follower of the Bernanke doctrine, as are, among others, Governor Sarah Raskin and Vice Chairwoman Janet Yellen. Yellen, a top contender for the next Fed chair, has said, "I think most central bankers view monetary policy as a blunt tool for addressing financial stability concerns and many probably share my own strong preference to rely on micro- and macroprudential supervision and regulation as the main line of defense."

Governors Jeremy Stein and James Bullard are among the group who don't buy the Bernanke doctrine; they believe that monetary policy (i.e. higher interest rates) should be used to "fight financial excess a little more than we have in the last few years." Larry Summers, also considered a top contender, fits more into this group, expressing concerns that the Fed's monetary policy of recent years creates "an environment that’s going to increase the risk of – going to increase the risk of bubbles."

So I think President Obama's comment, "if the markets start frothing up, let’s make sure that we’re not creating new bubbles," reveals who has his ear, and maybe whom he has in mind: Summers.

But returning to "the lives of ordinary Americans getting better," here's Janet Yellen in 1995:
"I began by asking myself the question, what is it that the public cares about? The answer seems straightforward to me. It is not just high and variable inflation; that is not the only aspect of economic performance people care about. The public also cares about real outcomes. Households and businesses very much dislike fluctuations in output and employment, for good reasons. Quite naturally, they prefer higher average output and lower average unemployment. I consider these goals eminently sensible, not foolish nor irrational. 
Then I ask myself, what is it that the Fed can accomplish? I conclude that the actions of this Committee affect not just the level and variability of inflation but also at a minimum the variability of output and employment. I know that some people would argue against our trying to reduce the variability of output on the grounds that economic forecasting is so uncertain and that there are long and variable lags in monetary policy, so maybe all we would do is to destabilize the economy rather than stabilize it. But when I look at the record, I just do not agree. It seems to me the record shows that within limits, tuning works even if it is not "fine."... 
The moral I draw is simply that the Fed should pursue multiple goals. It follows almost automatically that when the American people have sensible multiple goals and the Federal Reserve affects multiple dimensions of economic performance, that the Federal Reserve Act should enshrine all of those goals and we should do our best to honor them... I understand that the mandate of the Federal Reserve Act to pursue multiple goals is pretty vague. There really is no guidance in the Act as to how to call the tough trade-offs. But I see the objectives as fundamentally sound, and I think this Fed, in pursuing those goals, has enhanced social welfare...I want at least to mention that if this Committee were to decide that it really wanted a quantitative monetary policy rule incorporating a numerical inflation target--for example, because it was thought to be important to have a nominal anchor for monetary policy--we should not go with the type of rule embodied in the Neal amendment, which is a pure inflation targeting scheme. Why? Because there clearly are better rules. We could talk about those at length but a simple approach, not necessarily the best, that dominates inflation targeting would be a hybrid rule that would adjust monetary policy--and this could be a mechanical rule if it were so desired--on the basis of two gaps, not one. These would be the gap between actual and target inflation and also the gap between actual and potential output...Uncertainty about sales impedes business planning and could harm capital formation just as much as uncertainty about inflation can create uncertainty about relative prices and harm business planning."
She got it then and she gets it now. I could say more about her remarkable credentials, but plenty of people have already jumped in to do so in the last week. I can only echo that she is the best choice to replace Chairman Ben Bernanke at the Fed.

***Fun fact: My high school, like most high schools, voted on "senior superlatives" (most likely to succeed, best athlete, etc.) Oddly, I was given "Most likely to be the next Alan Greenspan." I say oddly because I had no interest in economics at the time, and still didn't for another few years after that. Obviously, I did not become the next Alan Greenspan. Ben Bernanke beat me to it! But I was still tickled by Binyamin Appelbaum and Annie Lowrey's remark that "President Obama’s choice of a replacement for the Federal Reserve chairman, Ben S. Bernanke, is coming down to a battle between the California girls and the Rubin boys," and to have the great pleasure of being associated with the California girls!

10 comments:

timm0 said...

The President notoriously appoints people who are Friedman-esque in their thinking to economy-related positions.

Prepare for another bad choice in a long line of terrible choices.

Peter said...

Good catch. It will probably be Summers.

There's also that anecdote from his first term where Obama said he thought monetary policy had done all it can do, and his CEA chair Romer rightfully disagreed with him.

I also wonder if Obama is still in crisis mode with fighting Republican brinkmanship over the debt ceiling and the budget. Hence he still wants "old-hands" on deck. I would argue this shouldn't disqualify Yellen who was at the Fed throughout the crisis years.

Dan Kervick said...

Carola, I think you are over-interpreting the comment. Obama mentions the price stability part of the mandate in the first half of the paragraph and the unemployment part of the mandate in the second half the paragraph, then says a few things about financial stability. He's just a politician emitting the usual content-free word clouds to please all of the various audiences and show that he has some vague idea about the Fed's role. I wouldn't read anything important into it.

Economists often suggest that they know the "true meaning" of the Fed's mandate in a given context. But the so-called "dual mandate" is an intentionally vague piece of legislative fluff that offers no really definite guidance. First of all its not a dual mandate, it's a three part mandate. The relevant text is:

"The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates."

The logical structure here is: the Fed shall maintain A commensurate with B so as to promote C, D, F.

What economists refer to as the "dual mandate" is the D, E and F part - which clearly contains three components, not two:

1. maximum employment
2. stable prices
3. moderate long-term interest rates

The legislation contains zero guidance as to what level of employment is to be considered "maximum"; nor does it even say which of the many measure of employment the Fed should use in aiming at this maximum level.

The legislation is also economically out of date in its reference to maintaining long run growth in monetary and credit aggregates as the means by which the Fed should promote the other goals. This hearkens back to an early monetarist era in which it was thought the Fed could directly target monetary and credit aggregates, and that the changes in those aggregates determined everything else. But the Fed abandoned attempts to target monetary aggregates decades ago, and for good reason: they found they couldn't do it.


Dan Kervick said...

Sorry for the confusion of variables. I should have said:

The logical structure here is: the Fed shall maintain A commensurate with B so as to promote C, D, E.

What economists refer to as the "dual mandate" is the C, D and E part - which clearly contains three components, not two:

Anonymous said...

After your post was published Gavyn Davies in the Financial Times seemed to have the same thought, that Obama's comment seemed to reflect Summers' view:

quote
Mr Summers seems to be worried that a bubble is building in US asset prices, something the President chose to emphasise last week when he was framing his thinking on the Fed leadership.
end quote

http://blogs.ft.com/gavyndavies/2013/07/28/summers-time-at-the-fed/

Dan Kervick said...

There is more than policy going on here. Summers represents the last hurrah of the turn-of-the-century Democratic Party's most insiderish clique of money men: people like Rubin and Corzine. Summers was Rubin's right-hand man and they were joined at the hip with Greenspan. Why these characters, the key architects of a spectacularly failed system, still get the time of day in the White House probably depends more on their political connections and control over Democratic Party coffers than it has anything to do with positions on the fine points of economic theory and policy.

Obama could be under pressure from Hillary's camp to appoint Summers, since Summers is an old part of the Clinton machine. If Obama is "comfortable" with Summers, that's probably what's going on. Also, Obama may have promised Summers the Fed position last year to get Summers and his henchmen to back off on their opposition to Jim Yong Kim.

rickstersherpa@msn.com said...

Well, obviously per Larry Summers since you and Janet Yellen are gilrs you are just no good at economics. Unlike his sterling record of running things into the ground!!! Comments made by Obama and the pro-Wall Street policies he implements leaves me just "Gobsmacked" when I hear the Yahoos on Faux News adn Faux Business News calling this right-of-center President a "Socialist," "Marxist," and "Black Nationalist." Talk about moving the Overton Window.

Anonymous said...

I think Obama is just equivocating to placate the the special interests (i.e. the business community) There is no hidden meaning -- unless he does nominate Summers in the end.

Peter said...

Krugman links to(!) Blinder agrees with her:

http://krugman.blogs.nytimes.com/2013/07/29/fear-of-froth/

Fear of Froth
by Krugman

July 29, 2013

Carola Binder parses President Obama’s big interview with the Times, and thinks it hints at a Summers, or anyway non-Yellen appointment. Maybe; in any case, can I say just how really stupid it is for the White House to have allowed this show even to get started? Here we have Obama trying to reboot his economic message, and much of the reporting is instead focused on palace intrigue."

Krugman adds:

"And this has, by the way, been true all along. Back in the fall of 2009 the word I got was that senior Administration officials believed that we were in a Treasury bubble,and that long-term interest rates — then around 3.5 percent — might soar any day now. This in turn was partly behind the disastrous “pivot” away from unemployment to deficits."

Anonymous said...

Larry Summers vs. Janet Yellen is just a good-cop bad-cop con. Both are equally corrupt, and equally determined to boost Wall Street at the expense of the average American. Of course, otherwise why would Obama consider nominating her?

What these corporate shills say in their press releases means nothing. Consider Obama himself, who talks like FDR but walks like Marie Antoinette. 'The poor, they have no bread? Say how much we feel their pain and let them starve!'